Thursday, August 30, 2012

The Dow Theory gives us order. It provides us with a framework to analyze the market.

We fail at making money in the
markets not because of a lack of tools but because we (1) lack consistency in
using our tools, (2) have an undefined time-frame and (3) lack of well defined exits
(stops)

Dow Theory addresses these three
issues: It allows us to be consistent. Of course, to be consistent you have to
believe in it. And such faith in Dow Theory will come from focused study. Dow
Theory is based on a definite set of rules which make sense aprioristically and
empirically. And we also know that it works, since the Dow Theory has a proven
track record spanning more than 110 years. Few technical systems can boast such
outstanding “back testing results”. The rules are sufficiently defined and
psychologically bearable so that we consistently use them and not jump from one
method to the next while our losses mount. When the Dow Theory is properly
digested (and hopefully this blog helps you at that) it is easy to buy when it
says to buy and to sell when it says “sell” (which usually translates into “get
out of danger and run for the exits”).

It has clearly defined time-frames. We know the time it takes for a movement to be qualified as a correction,
we roughly know what to expect (at a minimum) of a primary movement both in
time and extent. We know that to qualify as a rally price action must have a
magnitude of at least 3%. Dow Theory gives us a yardstick with which we can
assess market conditions. Personally, without the Dow Theory yardstick I am at
a loss when trying to make sense of the markets. It is like being unable to read.
Without Dow Theory I feel market illiterate.

And last but not least, the Dow
Theory tells us when to run for the exits. As Buffet said the first rule of
investing is not to lose money, the second one not to forget the first one.
Most fortunes are lost (not only in trading/investing but mainly by
entrepreneurs but this is the subject for another post) by not knowing when to
get out. In other words, capital is usually lost by poor timing. Dow Theory,
while not having hard defined stops (and this is good to avoid stop running), adapts
to the vicissitudes of the market and tells us when to get out. Studies show
that rarely the Dow Theory gives away more than 10% of the unrealized gains from
the top. Hence it helps us keep our power dry and while sitting on the
sidelines in cash, expect the next bull wave (primary movement).

Dow Theory gives order to the
universe or, at least, a powerful tool to analyze it. When one learns to
identify a primary swing, a correction, a rally, etc. one is able to see the
market as if through a kaleidoscope. Suddenly all the crystals fall in place.

About Me

Disclaimer/Disclosure

This blog (dowtheoryinvestment.com) is strictly a personal journal applying my interpretation of Dow Theory principles to the action of the stock market and my musings about investment and trading in general. This blog is intended solely for entertaining, illustrative or informational purposes. I am not a registered investment advisor and neither the information nor the opinions expressed should be construed as a solicitation to buy or sell any stock, option, ETF, mutual fund, currency, commodity, or any other security. I am unaware of any readers personal circumstance, financial condition, risk tolerance or goals and objectives, so nothing read here should be considered advice suitable for them. Anyone reading this blog does so with the understanding that this is strictly meant as an analytical exercise and does not proffer actionable advice in any way, shape or form. Trading and investing always entail risk and possible loss of funds and should only be undertaken after appropriate due diligence by the trader/investor and after consulting a registered investment adviser.